CVS announced this morning (01/18/19) that WMT will continue to participate in the CVS Caremark networks. Recall that on Tuesday (1/15), CVS announced the termination of contract (Medicaid & Commercial only) with WMT due to a dispute over pricing/reimbursement. We expected the potential disruption to be manageable even if WMT were to opt out from the networks. The companies stated that they “have reached a mutually agreeable solution” on “fair and equitable terms” without disclosing the financial terms of the new contract. We believe less than 4% of CVS’s scripts are filled in Walmart, given higher Caremark member penetration in CVS’s own retail pharmacies and WMT’s skew to cash customers.
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CVS announced that WMT has opted to leave the CVS Caremark commercial and Medicaid retail networks in a dispute over pricing/reimbursement. CVS does not expect the network termination to have a material impact on 2019 financial results as the co. focuses on transitioning impacted members to other network pharmacies. CVS has requested WMT to fill prescription for its members through the end of April (from current Feb 1st) and remains open for further negotiations to reach an agreement on pricing. Recall that in 2012, Walgreens terminated its retail network contract with ESRX, citing reimbursement rate cuts as one of the reasons. In its earnings calls in 2012, ESRX noted that the termination “wasn’t a big negative” and the clients had “virtually no disruption”. Arguably, the potential disruption caused by the WMT-CVS termination should be less, given WMT’s current pharmacy market share of ~4-5% (on rev basis) vs. ~15-16% market share of Walgreens at the time of the termination. We believe less than 4% of CVS’s scripts are filled in Walmart, given higher Caremark member penetration in CVS’s own retail pharmacies and WMT’s skew to cash customers.
We are updating our CVS/AET pro-forma model to reflect additional information provided by the co. on the transaction and FY19 headwinds/tailwinds discussed at a recent investor conference. Our new FY19 EPS of $7.20 is ~3.5% below the current Consensus est. of $7.46, with the decline vs. our previous $7.68, primarily driven by (1) assumed post-deal investment spending of $250m or $0.14 (2) incremental rebate guarantee payouts of $300m or $0.17 (see our previous notes on the topic here and here) and (3) a slightly more conservative ramp on synergies from $350m in Year 1 to now assuming $250m in Year 1, a $0.06 impact. See pg. 3 for a summary of our pro-forma model and this link for our working CVS model. Recent conversations indicate investor expectations for initial guidance are all over the board, ranging from $7.00 - $7.50 with the recent stock price action clearly indicating a fair amount of angst here.
At an investor conference, CVS highlighted muted brand inflation as one of the headwinds in FY19 and expects to see impact on client commitments in the PBM business, including guaranteed rebates. We spent considerable time in our PBM launch and webcast discussing our concerns around rebate guarantees going into 2019. Effectively PBMs have contractually guaranteed clients improving absolute $ rebates and this could be a risk should brand pharma gross price inflation remain moderate, leading to less $ rebates from manufacturers. Many 2019 contract terms were underwritten in 2015-2017 when brand inflation was higher and recent moderation here is likely to cause a shortfall in the gross rebate earned from manufacturers vs. what was guaranteed in the client contracts. See Pages 3-5 for our initiation slides on rebate guarantees.
We Remain Constructive on MCOs but See Risk/Reward More Balanced. MCOs have a strong fundamental backdrop and several tailwinds (HIF holiday / investment income) that support unique earnings visibility into 2019. That said, given current relative valuations appear to reflect much of this 2019 MCO earnings momentum we take a more measured view on the group as there are a number of potential factors that could weigh on sentiment and operating performance going into 2020. See PDF page 11 below for more details on these potential factors and please join our webcast this morning at 11am ET (click here to register) where we will discuss our views and answer questions.
In December Individual MA enrollment increased 7.2% y/y and Group MA enrollment increased 11.9% y/y, producing total y/y Med Adv growth of 8.1%. 62.1% of total MA enrollment of 21.3M lives were in our covered cos vs. 58.5% of 19.7M lives y/y, with the increase driven by both market share gains and M&A. Dec data demonstrates the typical intra-year seasonality post Annual Election Period with generally consistent m/m growth. See Page 2 for data by plan and email us for our tracking spreadsheet
While not unexpected given recent focus here from investors, Friday’s ruling is certainly unfortunate given potential for angst (even if we think it is very low probability) into likely Supreme Court decision in early-to-mid 2020 coupled with recent market volatility heightening stock moves such as JNJ 10% selloff on Friday. In this note we attempt to lay out and quantify where possible, various ACA related impacts to both MCOs and Hospitals to better understand the potential moving parts here should the ACA be struck down. In short we think it is very unlikely the Supreme Court votes this down on third try given 5 Justices remain who have voted to uphold 2 previous times in last 6 years - as we lay out in attached slides and will discuss on webcast at revised time of 8:30am ET. Thinking about stocks across the sector we see diversified MCOs best positioned, hospitals potentially less negatively impacted than investors might expect and CNC/MOH most negatively exposed.
The latest version of the House Republican Tax bill – known as the “Retirement, Savings, and Other Tax Relief Act of 2018 and the Taxpayer First Act of 2018” or H.R. 88 – released today includes extending HIF suspension by two years to the end of 2021 (see exact language on page 2). The current version of the bill is designed as a follow-on to the Tax Cuts and Jobs Act of 2017. It appears Republicans are unlikely to get the required support of Democrats to pass the Bill given the length / complexities of the current version and time constraints into year end, and under a new Congress this Bill would likely be adjusted. While the overall legislation is likely dead on arrival, we see the inclusion of a 2-year HIF suspension as a positive development for Managed Care as it indicates will is there in D.C. and focus now shifts focus to the potential “must move” legislative vehicles between now and next spring, such as those for government funding / appropriations as well as potential cost offsets which we expect would be in the $35 billion range.
Yesterda(1after market close CMS issued proposed MA / Part D drug pricing policy changes for 2020 (proposed regulation / announcement / factsheet). The most important change to the current policy is to provide Part D plans with greater flexibility to negotiate discounts for drugs in “protected” therapeutic classes by allowing sponsors to: (i) implement broader use of prior auth and step therapy; (ii) exclude a protected class drug from a formulary if only minor advancements are made vs. older drug; and (iii) exclude a drug if the price increased beyond a certain threshold over a specified look-back period. Other proposals that should be cost savers to Part D and Med Adv include (i) Part D sponsors to implement a system (real-time benefit tool) to provide prescribers with real-time member drug cost data – sounds a lot like UNH’s Pre-Check My Script; (ii) MA plans to implement step therapy for Part B drugs (similar to the rule implemented for 2019); (iii) Require the inclusion of drug pr
Earlier this morning (11/26/18) CVS and AET filed an 8K stating the companies had received the final regulatory approval required for the completion of the CVS-AET transaction. The 8K stated the closing is expected “to occur on or about November 28, 2018, subject to the satisfaction of all other closing conditions” – the first time an actual date has been put on the closing. The NYDFS’s approval conditions (see page 2 for full conditions) include some financial conditions, consumer and health insurance rate protections, privacy controls, cybersecurity compliance, and a $40M commitment to support health insurance education and enrollment. CI-ESRX has also recently reiterated they expect deal close by year-end – we note CI-ESRX’s hearing with the NY DFS is currently scheduled for December 7th so completion before then is unlikely.
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